Sustainable finance includes not only green or social finance, but also transition finance.

As 2020 draws to a close, governments around the world have their sights set on rebuilding our global economy in the wake of the COVID-19 pandemic.  Amidst the immediate economic priorities of job creation and growth, global awareness of climate change is also at a record high. There is now recognition from both the government and private sectors of the need to prioritise rebuilding our economy in a sustainable manner. 

In parallel with these developments, investors seeking opportunities to support a net zero global emissions footprint by 2050 are starting to recognise that the achievement of this goal requires more than increased investment in low emission technologies and other green projects.  It also requires a focus on incentivising ‘brown’ sectors to transition to greener activities, at a reasonable cost and without a long-term impact on growth. The companies in these sectors cannot become green in the short term because they do not have access to an economically viable green alternative, but they can become less ‘brown’. Financing the cost of transitioning from ‘brown’ to ‘light brown’ is known as ‘transition finance’. 

This article explores the emerging area of transition finance, looks at its key features and Australia’s involvement and experience in this area to date and considers what the road ahead looks like for the Australian market. While transition finance products can relate to any or a combination of a borrower’s environmental, social or governance (ESG) objectives, this article will focus on the ‘E’ in ESG, being those financial products relating primarily to a borrower’s environmental goals.

What differentiates transition finance from other sustainable finance?

Although transition finance comes under the umbrella of sustainable finance, it should not be confused with social or green finance.

A use of proceeds approach is core to both social and green finance. For example, bonds and loans cannot be labelled ‘green’ unless the proceeds are utilised to finance a green purpose or project.

In contrast, transition finance focuses on sustainability impacts in the form of sustainability-linked loans (SLLs) or bonds (SLBs). These instruments typically include a pricing adjustment (up or down) if the borrower achieves specified sustainability or ESG targets (e.g. lowering GHG emissions intensity) – achievement of the agreed targets results in financiers agreeing to accept a lower return in exchange (i.e. in return for the borrower’s sustainability improving). Alternatively, borrowers may be penalised with an increase in interest rates if the agreed target is not achieved. These cost incentives provide support for a net zero emissions footprint by 2050, and at the same time strengthen the resilience of borrowers against climate change risks. Bank lenders who provide these products are also better positioned to reduce their exposure to climate-related systemic risks such as higher capital costs for credit extended to carbon-intensive sectors.

Key Takeaways

  • Transition finance is any form of funding where pricing is linked to the achievement of stated ESG objectives.   Issuers for whom it is more difficult to issue a ‘use of proceeds’ ‘green’ bond have embraced the opportunity to demonstrate their ESG commitments via transition finance.
  • Australia’s transition finance market is in its infancy, with most of the banked deals taking the form of SLLs. Europe’s transition finance market is the most developed, with SLLs now a mainstream product and the implementation of sustainable finance mechanisms being driven by the EU’s Taxonomy Regulation.
  • Although the SLB market has been slower to develop, it will receive a boost from the recent publication in June 2020 by the International Capital Market Association (ICMA) of voluntary guidelines for market participants to follow when assessing whether a bond constitutes transition finance. This follows the publication of similar guidelines for the SLL market in March 2019.
  • The guidelines establish core criteria which SLLs and SLBs must satisfy - these include the setting of ‘ambitious’ performance targets, verification and reporting. In addition, SLBs involve the setting of ‘credible’ KPIs and ‘meaningful’ changes in bond characteristics to incentivise the achievement of performance targets.
  • More work is required by the market to develop standardised terminology and methodologies, that complement the existing guidelines and principles, for assessing whether SPTs or other performance targets have been achieved.
  • Notwithstanding these challenges there are several factors positioning SLLs and SLBs as the most effective platform for incentivising companies in ‘brown’ sectors to transition to a lower carbon footprint. The clear signals from investors and financiers that they are willing to support this transition suggests that SLLs will continue to grow on an exponential basis in the near to medium term, with SLBs well positioned to gain more traction amongst the investor community.

How does the market assess whether transition finance is credible?

Principles for SLLs and (more recently) SLBs have been published to support the development of the sustainability-linked finance markets. The Sustainability Linked Loan Principles (SLLPs) were issued in March 2019, by the Loan Markets Association (LMA), together with the Asia Pacific Loan Market Association (APLMA) and the Loan Syndications and Trading Association (LSTA) as a set of voluntary guidelines for market participants to follow when assessing whether a loan constitutes transition finance.  The Sustainability-linked Bond Principles (SLBPs) were issued by the International Capital Market Association (ICMA) in June 2020 as a set of similar voluntary guidelines for assessing whether a bond constitutes transition finance.

The SLLPs are intended to apply to any type of loan and/or contingent facility that incentivises the achievement of ambitious, sustainability-related performance objectives - these principles therefore also capture bonding lines, guarantee lines or letters of credit. This can be compared to the SLBPs which only apply to sustainably-linked bonds. The SLLPs are also primarily focused on improving market participants’ understanding of SLLs and comprise four key components:

  • Relationship to Borrower’s Overall Sustainability Strategy;
  • Target Setting – Measuring the Sustainability of the Borrower;
  • Reporting; and
  • Review.

In contrast, the SLBPs aim to implement standard approaches to SLB structuring and disclosure to facilitate credible transactions for investors. The SLBPs comprise five core components:

  • Selection of Key Performance Indicators (KPIs);
  • Calibration of Sustainability Performance Targets (SPTs);
  • Bond characteristics;
  • Reporting; and
  • Verification.

What is the key difference between the guidelines for SLLs and SLBs?

The third component of the SLBPs is the key departure from the SLLPs, covering how the bond terms will vary based on the performance of the issuer against its stated sustainability targets. While the most common structure will be an interest rate adjustment mechanism, it is possible for other structural features to vary too (such as requiring any potential windfalls associated with failing to achieve performance targets to be utilised for ESG purposes). The most important aspect of SLBs, however, is ensuring that the incentives or disincentives are meaningful for the issuer. Including this component in the SLBPs assists investors to understand how the incentives (or disincentives) are embedded into the terms of the bonds in which they are investing. This is critical if the SLB market is to expand at a rate similar to the growth of the SLL market.

Another difference is that SLBPs are more detailed and prescriptive, particularly in relation to public disclosure and the need for externally verifiable KPIs for SLBs – this can even go as far as providing a detailed disclosure checklist for SLBs. The SLBPs strongly encourage issuers to publicly disclose their SPTs, the rationale for their selection and how and when the SPTs are projected to be satisfied, as well as reporting on the performance of the KPIs over the term of the bond.

In most other respects, the SLLPs and SLBPs are similar in their operation and scope, as demonstrated in the following table.

Table of comparison: SLBPs to SLLPs


Sustainability Linked Loan Principles (SLLPs)

Sustainability-linked Bond Principles (SLBPs)

Application of principles

Any SLL or contingent facilities (e.g. such as bonding lines, guarantee lines or letters of credit).

SLBs only.


Relationship to borrower’s overall sustainability strategy



Selection of KPIs

Borrowers are encouraged to first determine the overall objectives, strategies, policies and processes which underpin their sustainability strategy.  Borrowers are then encouraged to take these objectives, strategies, policies and processes into account when conducting their target setting.

During the preliminary stages of target setting, borrowers should also disclose to potential financiers any standard or certifications with which they are trying to conform.

Issuers are strongly encouraged to disclose to potential investors their sustainability-linked KPIs.  KPIs should be of high strategic significance to the issuer’s current and/or future operations and measurable on a consistent methodological basis.  Issuers are encouraged to take these KPIs into account when setting their SPTs.

Ideally, KPIs should be capable of being benchmarked using an external reference or definitions to facilitate the assessment of the SPT’s level of ambition.

Issuers are encouraged to use KPIs that demonstrate historical performance.  The KPIs resulting from this process differ from the overall sustainability strategy disclosed under the SLLPs in the sense that KPIs are narrower, are capable of being measured on an objective basis and relate more to sustainability objectives (as opposed to processes, strategies and policies).


Target setting



Calibration of SPTs

Borrowers are encouraged to set performance targets (these are equivalent to the SPTs set for SLBs), taking into account the borrower’s overall sustainability strategy.

Targets should be meaningful, ambitious and tied to a sustainability improvement which has a predetermined performance benchmark.

The loan terms should provide the Borrower with a reward if the targets are met, and possibly a penalty if they are not.

Borrowers should develop internal expertise to verify targets if not using a third party.

Issuers are encouraged to calibrate (or in other words, set) SPTs that are ambitious. More specifically than the SLLPs, SPTs should be based on:

  • the issuer’s own performance with respect to KPIs over at least a period of three years;
  • the issuer’s peers and its relative position; and
  • reference the science (i.e. absolute levels or carbon, or to international targets like the Paris Agreement).

Issuers should develop their own expertise to verify their methodologies if not using a third party.

Bond / loan characteristics

No separate and specific component.



The defining characteristic of the SLB is the financial and/or structural characteristics that are triggered if SPTs are met (or not met). Those changes should be commensurate and meaningful relative to the issuer’s original bond financial characteristics.


Importantly, fallbacks should be explained in the event that the SPTs cannot be calculated or observed in a satisfactory manner.


Borrowers should, where possible, make up to date information relating to its SPTs publicly available. However, it is acknowledged that borrowers in the loan market may strongly resist public disclosure.

Issuers should make publicly available and easily accessible:

  • up to date information on their performance against their SPTs;
  • a verification assurance report regarding each SPT outlining the progress towards it and the impact and timing of satisfying it on the bond’s financial and/or structural characteristics; and
  • any information enabling investors to monitor the level of ambition of the SPTs (for example any update in the issuer’s sustainability strategy).

Review / Verification

Annual third-party review of the borrower’s performance against its targets is strongly recommended and desirable. 

The issuer should seek independent, external verification of its performance by a qualified reviewer with relevant expertise, at least annually. This should be made publicly available.

How does the criteria underpinning the guidelines operate in practice?

Target setting

A key requirement for transition finance is the requirement for borrowers and issuers to set performance targets.  Under the SLLPs, these are to be developed by the borrower taking into account its overarching sustainability strategy and agreed with the financiers.  Under the SLBPs,  the performance targets (ie, SPTs) are expected to be based on an issuer’s KPIs. In some cases, targets may conform with existing standards or certifications, but generally vary from borrower to borrower (or issuer) and across industries – this can cause headaches for financiers and investors when trying to compare targets across industries and transactions.  More work is required by the market to develop standardised terminology and methodologies for assessing whether performance targets have been achieved (either developed ‘upwards’ or ‘downwards’ by each industry) to complement the SLLPs and SLBPs.

Under both SLLs and SLBs, borrowers and issuers will receive a reward for meeting targets, usually via a reduction in the applicable margin or coupon (which benefit may cease to apply if the borrower or issuer fails to maintain those targets). In addition, a failure to meet targets will result in a penalty, usually through an increased margin or coupon.

Interestingly, the concept of a penalty raises the question of what financiers should do with the windfall that arises from a margin step up. Some banks in Europe have donated such windfalls to charity, but this is far from a perfect solution. A windfall presents a particular issue for investment managers without a dedicated sustainability fund or ESG mandate through which to re-invest the windfall. However, this issue may fall away as ESG mandates and dedicated sustainability funds become more commonplace.

The SLLPs provide examples of performance targets for SLLs, as summarised in the table below. Although the SLBPs do not provide any specific examples for SLBs, the below examples may well be equally applicable to SLBs.

Target Category


Energy efficiency

Improvement in the energy efficiency rating of buildings and/or machinery owned or leased by the borrower.


Reductions in GHG emissions in relation to products manufactured or sold by the borrower or to the product or manufacturing cycle.

For example, Queensland Airports’ 2019 SLL provides for lower interest rates if the airport reduces its carbon emissions by 15 per cent before 2021.

Renewable energy

Increases in the amount of renewable energy generated or used by the borrower.

For example, AGL’s recent SLL featured SPTs for increased renewable energy and storage capacity.

Water consumption

Water savings made by the borrower.

Affordable housing

Increases in the number of affordable housing units developed by the borrower.

Sustainable sourcing

Increases in the use of verified sustainable raw materials/supplies.

Circular economy

Increases in recycling rates or use of recycled raw materials/supplies.

Sustainable farming and food

Improvements in sourcing/producing sustainable products and/or quality products (using appropriate labels or certifications).

For example, COFCO International tied its facilities’ margins to the increased traceability of agri-commodities, focusing on directly-sourced soy from Brazil.


Improvements in conservation and protection of biodiversity.

Global ESG assessment

Improvements in the borrower’s ESG rating and/or achievement of a recognised ESG certification.

A common measure of this rating is the Sustainalytics ESG Risk Rating, which Sydney Airports used as a benchmark in its recent debt facilities and bond issuance.


Reporting is another key aspect of transition finance. While there is currently no standardised methodology for reporting on performance targets, borrowers and issuers must maintain up to date information relating to their targets, their progress towards reaching them and the methodology and assumptions applied to target reporting.

Under the SLBPs, issuers are also strongly encouraged to publicly disclose performance against their targets in the interests of transparency and good faith. Although this should deliver marketing benefits for borrowers that can boast of achieving ambitious targets, borrowers often prefer private reporting for a number of reasons. Aside from proprietary and competition considerations, another reason for this can be the downside of publicly disclosing a failure to meet SPTs through damage to an issuer’s reputation and investor confidence.

Regardless of the degree of disclosure or the method of reporting, one notable benefit of SLLs/SLBs for financiers and investors is the far greater degree of reporting provided by borrowers and issuers, compared to that provided under equivalent vanilla loan or bond instruments. 


Transition finance requires the borrower’s or issuer’s performance against the agreed targets to be regularly reviewed (and the SLLPs and SLBPs encourage this be done at least annually). Third-party review is strongly recommended, accompanied to the extent possible by public disclosure of the outcomes of the reviews. In some cases, financiers or investors may be happy to rely on a publicly listed entity’s public disclosures to verify target satisfaction – however, it may still be desirable to have certain targets reviewed externally (for example, in the case of a target relating to sustainable sourcing where the borrower/issuer cannot track the various supply lines with sufficient certainty).

External reviews are generally conducted by auditors, environmental consultants or an agreed agency (such as Sustainalytics).  Alternatively, in the case of internal review, the borrower or issuer should be in a position to demonstrate to financiers or investors that it possesses the internal processes and expertise necessary to validate its performance against the targets and should publicly disclose that information.

Regardless of the method chosen, financiers and investors will assess the results of the review and the borrower’s or issuer’s performance against the relevant targets and apply the discounted pricing (i.e. margin reduction) if the targets have been met or apply the penalty if not (i.e. margin increase). 

See the following transition finance case studies which demonstrate how the above principles are applied in practice.

Sustainability-linked loan (SLL)

In May 2019, Sydney Airport refinanced $1.4 billion of syndicated debt facilities via the first syndicated SLL, the largest SLL in the Australian market and the largest airport SLL globally. The deal is tranched across three, four and five-year maturities and the bank debt facilities margins decrease or increase depending on Sydney Airport’s sustainability performance over time.

The loan incentivises ESG outcomes by Sydney Airport group members by reference to an independently assessed sustainability benchmark. The performance is assessed by independent third party Sustainalytics. Sydney Airport’s sustainability performance targets are spread across a number of areas including corporate governance, human capital, business ethics, emissions, effluents and waste, and health and safety.

Sydney Airport’s performance against these targets is measured using Sustainalytics’ ESG Risk Rating which distils a range of sector-specific factors into a single performance measure. The use of this rating has become increasingly common for corporates issuing sustainability-linked debt. The rating measures the degree to which a company’s value may be at risk due to ESG issues. To be considered material to the risk rating, an ESG issue must have a potentially substantial impact on the economic value of a company and therefore on the risk/return profile of an investment in the company. The rating takes into account these risks and the unmanaged ESG risk exposure after factoring in the company’s ESG management activities.

Sustainability-linked bond (SLB) issuance

In February 2020, Sydney Airport raised around $600 million from a multi-tranche, triple currency US private placement which included a $100 million SLB tranche. This was the first SLB issued out of Australia and the first globally to include a pricing step-up and step-down based on performance against its SPTs.

The SLB includes a four-month delayed settlement and the coupon on the notes will increase or reduce depending on Sydney Airport’s sustainability performance and disclosures, as assessed by Sustainalytics.

The deal was in the pipeline for quite some time as investors educated themselves on the SLB components and priced the deal. Being the first of its kind in Australia there were a number of moving parts to be considered and negotiated, particularly the complexity involved in the pricing step down. Ultimately, such complexities were overcome due to the investors’ experience with providing structural flexibility for complex transactions and their focus and dedication to sustainability.

This novel deal will undoubtedly pave the way for more bond issuances of this kind as the transaction structure becomes more widely understood by corporate issuers and investors.


In July 2019, COFCO signed USD 2.3 billion of senior unsecured sustainability-linked facilities in a deal involving the largest sustainability-linked facility for a commodity trader. COFCO engaged 21 banks on the loan and was assisted by Rabobank as its “Sustainability Co-ordinator” in setting externally verifiable performance targets. The facilities comprise a one-year revolving credit facility, a three-year revolving credit facility and a three-year term loan facility.

The facilities’ margins are linked to the borrower’s sustainability performance and include a 5bps discount on the margin if the performance targets are hit. The performance targets include:

  • year-on-year improvement of ESG performance, as assessed by Sustainalytics; and
  • increasing the traceability of agri-commodities, with a focus on directly sourced soy in Brazil, as annually assessed by an independent inspector.

If the borrower meets the agreed performance targets, the related margin savings will be invested to further improve performance across sustainable supply, health and safety, environment, communities and upholding its sustainability standards. Both of the year one performance targets outlined above were satisfied.


In March 2020, Wesfarmers signed a three-year A$400 million SLL with Commonwealth Bank of Australia. The loan was the largest SLL to be offered by a single lender in the Australian market and the first loan of this kind in Australia to be linked both to social and environmental performance targets.

The interest rate paid by Wesfarmers is tied to reducing its carbon emissions intensity and increasing indigenous employment opportunities. The loan margins are linked to a reduction in the carbon intensity of Wesfarmers’ ammonium nitrate production, being the most carbon intensive part of its business, while the performance target relating to increasing indigenous employees among Wesfarmers staff aims for an improvement from 1.7% to 3%, bringing it in line with the Australian population.

The novel loan structure of having both environmental and social performance targets demonstrates the breadth of issues that can be addressed by transition finance products.


In October 2019, RUSAL (one of the leading global aluminium producers) announced the signing of a five-year sustainability-linked pre-export finance facility of USD1.085 billion with a syndicate of Russian and international banks.

The interest rate is subject to a sustainability discount depending on the borrower’s fulfilment of its performance targets, being:

  • increased sales of RUSAL’s "Allow" low-carbon aluminium brand;
  • reduction in the borrower’s carbon footprint; and
  • decreased fluoride emissions.

Performance against the targets is measured annually and verified by an independent, specialised and undisclosed third party. The year one targets were achieved and RUSAL was rewarded with a reduction in pricing of 15bps until mid-2021. Some market commentators are sceptical of the ambitiousness of the targets, particularly given the performance target relating to increased sales of the low carbon aluminium product was surprisingly achieved during the COVID-19 pandemic, though RUSAL have stated in response that the performance targets change year on year and, presumably, become more ambitious as the loan reaches its maturity.


Market Activity


The opportunity for investors to invest in historically ‘brown’ businesses to assist them in transitioning to a greener operating model has resulted in an exponential growth of SLLs offshore. In 2019, the global market grew by 168% and jumped in value to $122 billion USD, making SLLs one of the most popular types of sustainable finance debt (second only to green bonds). Domestically, Australia has banked five SLLs, being Adelaide Airport, Sydney Airport, Queensland Airports, AGL Energy and Wesfarmers. Although we are clearly at the beginning of this journey in Australia, we expect the SLL market to accelerate in line with the Government’s focus on Australia’s Paris Agreement commitments and the increasing calls for a net zero emissions economy by 2050.


The SLB market has struggled to gain traction since the first public issuance by ENEL in 2019. While the COVID-19 pandemic has possibly slowed the use of this structure, further factors may be at play. The lack of flexibility both in the negotiation of SLBs and the amendment of bonds once issued and the aversion of issuers to publicly disclosing SPTs and the pricing implications of not meeting them, may have hindered the development of the SLB market. However, the biggest hurdle for issuers is likely to be the additional cost and complexity associated with drafting SLBs – the drafting of an SLB requires careful consideration of the SPT fallbacks that will be applied if measurement methodologies change or become unavailable, as well as anticipation of novel legal issues that are symptomatic of bond issuances. Since companies are generally more comfortable with loan terms, this added complexity may deter issuers from using SLBs until standardised terms and frameworks are adopted.

The relatively slow proliferation of SLBs is in contrast with the green bond market, which is much more developed. From an investor appetite perspective, green bonds are more easily understood, and investors can clearly see the sustainable impact of their investment.  In contrast, the sustainability impact of SLBs is less obvious and more complex to assess from a pricing perspective. However, as participants become more comfortable with sustainably-linked debt generally, it is likely that SLBs will become more popular.

The future for sustainability-linked debt

The landmark decision of Blackrock to steer away from exposures to thermal coal and Fortescue Metals’ signing of the Australian Industry Energy Transitions Initiative demonstrates that big corporate players have an appetite for playing their part in the global move towards a net zero emissions economy.

There are several factors positioning SLLs and SLBs as the most effective platform for this transition.  In particular, unlike the ‘use of proceeds’ model that underpins green finance, transition finance can be applied more flexibly and be tied to a broader range of objectives impacting a borrower’s or issuer’s behaviour.   If one then takes into account the willingness of financiers and investors to provide support for transitioning brown businesses, we are likely to see continued exponential growth in the SLL market in future, with SLBs well-positioned to gain more traction amongst the investor community.


  1. SLBPs
  2. SLLPs
  3. EU Taxonomy Regulation

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